Continued economic uncertainty associated with the COVID-19 pandemic is concerning to Americans of all ages, especially those living in retirement. Below we address four questions retired investors are asking about ways to optimize their planning in the months ahead.
1. Should I waive my RMDs?
The Coronavirus Aid, Relief, and Economic Security(CARES) Act—the $2 trillion economic stimulus package signed into law in March 2020—waives required minimum distributions (RMDs) for those subject to them in 2020. RMDs are mandatory annual withdrawals from certain IRAs and retirement plan accounts that apply to investors once they reach a certain age. The SECURE Act, which took effect January 1, 2020, raised the age that retirement account owners must begin taking RMDs from age 70 ½ to age 72. (For those who turned 70½ on or before June 30, 2019, RMDs will still apply.) These distributions are also subject to taxes in the year the assets are withdrawn.
The ability to waive RMDs offers many benefits. For starters, it allows retirees to avoid cementing losses in long-term assets that may be subject to increased market volatility. Allowing these assets to remain invested provides more time for investments that may have been affected by the severe stock market drop in March to recover and generate future portfolio growth. And finally, waiving RMDs can substantially reduce taxable income in 2020.
However, many retirees depend on these distributions to supplement the income they receive from other sources, such as Social Security or a pension.
If you’re unsure if you should take or waive your RMD in 2020, consider whether or not you have other resources you can use to meet your short-term income needs, such as emergency savings or other cash reserves. At a minimum, you want to make sure you have enough income to take care of the necessities—food, shelter, clothing, health care, and transportation.
To learn more about managing RMDs, download our resource “Making Sense of RMDs”
2. Do I need to rebalance my portfolio?
Over time, market swings can throw your target allocation out of alignment with your goals and risk tolerance, creating the need to rebalance your portfolio.
Your “target allocation” represents the amount of risk you’re willing to take for a potential level of return on your investments. Your target allocation can become misaligned as individual investment holdings increase or decrease in market value or experience changes in the interest or dividend return they provide. As a result, certain types of holdings or asset classes, such as stocks or bonds, may take up a larger or smaller percentage of your portfolio than you intended. That has a direct impact on the amount of risk your portfolio may be subject to at any given time.
Rebalancing enables you to reallocate or redistribute your assets to get back to your initial, or target, asset allocation. Keep in mind, rebalancing does not protect against loss or guarantee that an investor’s goals will be met. It can also be challenging to do on your own, so you may want to enlist the help of a financial professional to review your portfolio allocation to see if it needs adjusting.
3. How can I generate income in today’s low interest rate environment?
Another reason your portfolio may need rebalancing is if certain holdings that performed well previously, no longer provide the same benefit in the current market. For example, in today’s low interest rate environment, many retirees are not able to generate the income they need from low-yielding bonds or bond funds.
Rebalancing may offer an opportunity for those seeking additional portfolio income to temporarily adjust their allocations to include longer-term, higher yielding bonds, which typically carry higher risk. Another alternative may be to increase holdings in high-quality dividend and income-paying stocks. Then, when bond market yields become more attractive, you can rebalance to your original target allocation. Keep in mind that allocating a larger portion of your portfolio to stocks will also increase the volatility of your portfolio.
4. Did I miss the window for harvesting tax losses?
The simple answer is “no.” While tax-loss harvesting is a helpful and often underused strategy during down markets, it’s not limited to periods of declining investment values. That’s because ongoing tax planning is a core part of any comprehensive financial planning and investment strategy.
Tax loss harvesting takes place when you sell an ailing equity at a loss, then take that tax loss and use it against an equity where you had a gain. By applying the loss against the gain, you effectively lower your investment tax burden. Losses can also be rolled year over year, which can be particularly beneficial during uncertain times.
Tax-loss harvesting can also benefit investors with concentrated stock positions. Maybe you inherited a large number of shares of a single security, or a stock you invested in “split” several times over the years, resulting in owning more shares than you originally intended. Often, investors may be reluctant to diversify these positions by selling shares, due to the large embedded capital gain. In many cases, diversifying a concentrated position in conjunction with a tax-loss selling strategy may help to minimize your overall tax burden.
A sub-strategy for tax-loss harvesting involves your losses on an index fund, and essentially relocating investments for better tax treatment. For example, if you own an index fund from a certain firm that’s experiencing a loss, you can sell it, reap the loss, and buy the same index fund again at a different firm with a different stock ticker.
For example, let’s say you have $10,000 in an index fund with a certain firm. This market loss hits this mix hard, as it will hit a lot of them, and you sell. You can reap the tax loss from that, and then re-invest that money in the same mix (different firm) and wait for the markets to come back up. Because, even in the worst of times, history has shown the old cliché to be true: Time in the market is better than timing the market.
If you’re considering a strategy that includes tax-loss harvesting, beware of the wash sales rule. The rule prohibits you or your spouse from purchasing an identical or substantially similar investment within 30 days of the sale if you want to claim the loss.
To learn more about tax planning, download our resource “10 Tax Planning Tips Your CPA Might Have Missed.”
If you’re looking for ways to optimize your planning in retirement, consider working with a financial professional to obtain the personalized guidance you need. An experienced, independent financial advisor can help you identify and implement the strategies aligned with your retirement lifestyle goals to help you manage risk, reduce tax exposure, and prepare for the opportunities ahead.